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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

Constant-Growth Model. You believe that the Non-stick Gum Factory will pay a dividend of $2 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 6 percent a year in
Negative Growth. Horse and Buggy Inc. is in a declining industry. Sales, earnings, and dividends are all shrinking at a rate of 10 percent per year.a. If r = 15 percent and DIV1 = $3, what is the
Constant-Growth Model. Metatrend’s stock will generate earnings of $5 per share this year. The discount rate for the stock is 15 percent and the rate of return on reinvested earnings also is 15
Nonconstant Growth. You expect a share of stock to pay dividends of $1.00, $1.25, and$1.50 in each of the next 3 years. You believe the stock will sell for $20 at the end of the third year.a. What is
Constant-Growth Model. Here are data on two stocks, both of which have discount rates of 15 percent:a. What are the dividend payout ratios for each firm?b. What are the expected dividend growth rates
P/E Ratios. Web Cites Research projects a rate of return of 20 percent on new projects.Management plans to plow back 30 percent of all earnings into the firm. Earnings this year will be $2 per share,
Constant-Growth Model. Fincorp will pay a year-end dividend of $4.80 per share, which is expected to grow at a 4 percent rate for the indefinite future. The discount rate is 12 percent.a. What is the
P/E Ratios. No-Growth Industries pays out all of its earnings as dividends. It will pay its next $4 per share dividend in a year. The discount rate is 12 percent.a. What is the price-earnings ratio
Growth Opportunities. Stormy Weather has no attractive investment opportunities. Its return on equity equals the discount rate, which is 10 percent. Its expected earnings this year are $3 per share.
Growth Opportunities. Trend-line Inc. has been growing at a rate of 6 percent per year and is expected to continue to do so indefinitely. The next dividend is expected to be $5 per share.a. If the
P/E Ratios. Castles in the Sand generates a rate of return of 20 percent on its investments and maintains a plowback ratio of .30. Its earnings this year will be $2 per share. Investors expect a 12
Dividend Growth. Grandiose Growth has a dividend growth rate of 20 percent. The discount rate is 10 percent. The end-of-year dividend will be $2 per share.a. What is the present value of the dividend
Stock Valuation. Start-up Industries is a new firm which has raised $100 million by selling shares of stock. Management plans to earn a 24 percent rate of return on equity, which is more than the 15
Nonconstant Growth. Planned Obsolescence has a product that will be in vogue for 3 years, at which point the firm will close up shop and liquidate the assets. As a result, forecasted dividends are
Nonconstant Growth. Tattletale News Corp. has been growing at a rate of 20 percent per year, and you expect this growth rate in earnings and dividends to continue for another 3 years.a. If the last
Nonconstant Growth. Reconsider Tattletale News from the previous problem.a. What is your prediction for the stock price in 1 year?b. Show that the expected rate of return equals the discount rate.
Sustainable Growth. Computer Corp. reinvests 60 percent of its earnings in the firm. The stock sells for $50, and the next dividend will be $2.50 per share. The discount rate is 15 percent. What is
Nonconstant Growth. A company will pay a $1 per share dividend in 1 year. The dividend in 2 years will be $2 per share, and it is expected that dividends will grow at 5 percent per year thereafter.
Nonconstant Growth. Phoenix Industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $1 per share dividend to be paid a year from now, the first
Nonconstant Growth. Compost Science, Inc. (CSI), is in the business of converting Boston’s sewage sludge into fertilizer. The business is not in itself very profitable. However, to induce CSI to
Nonconstant Growth. Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20 percent per year for 4 years. By
Rate of Return. A stock is selling today for $40 per share. At the end of the year, it pays a dividend of $2 per share and sells for $44. What is the total rate of return on the stock? What are the
Rate of Return. Return to problem 1. Suppose the year-end stock price after the dividend is paid is $36. What are the dividend yield and capital gains yield in this case? Why is the dividend yield
Real versus Nominal Returns. You purchase 100 shares of stock for $40 a share. The stock pays a $2 per share dividend at year-end. What is the rate of return on your investment for these end-of-year
Real versus Nominal Returns. The Costaguanan stock market provided a rate of return of 95 percent. The inflation rate in Costaguana during the year was 80 percent. In the United States, in contrast,
Real versus Nominal Returns. The inflation rate in the United States between 1950 and 1998 averaged 4.4 percent. What was the average real rate of return on Treasury bills, Treasury bonds, and common
Real versus Nominal Returns. Do you think it is possible for risk-free Treasury bills to offer a negative nominal interest rate? Might they offer a negative real expected rate of return?
Market Indexes. The accompanying table shows the complete history of stock prices on the Polish stock exchange for 9 weeks in 1991. At that time only five stocks were traded. Construct two stock
Stock Market History.a. What was the average rate of return on large U.S. common stocks from 1926 to 1998?b. What was the average risk premium on large stocks?c. What was the standard deviation of
Risk Premiums. Here are stock market and Treasury bill returns between 1994 and 1998:a. What was the risk premium on the S&P 500 in each year?b. What was the average risk premium?c. What was the
Market Indexes. In 1990, the Dow Jones Industrial Average was at a level of about 2,600.In early 2000, it was about 10,000. Would you expect the Dow in 2000 to be more or less likely to move up or
Maturity Premiums. Investments in long-term government bonds produced a negative average return during the period 1977–1981. How should we interpret this? Did bond investors in 1977 expect to earn
Risk Premiums. What will happen to the opportunity cost of capital if investors suddenly become especially conservative and less willing to bear investment risk?
Risk Premiums and Discount Rates. You believe that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What
Scenario Analysis. The common stock of Leaning Tower of Pita, Inc., a restaurant chain, will generate the following payoffs to investors next year:The company goes out of business if a recession
Portfolio Risk. Who would view the stock of Leaning Tower of Pita (see problem 14) as a risk-reducing investment—the owner of a gambling casino or a successful bankruptcy lawyer? Explain.
Scenario Analysis. The common stock of Escapist Films sells for $25 a share and offers the following payoffs next year:Calculate the expected return and standard deviation of Escapist. All three
Scenario Analysis. Consider the following scenario analysis:a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?b. Calculate the expected rate of
Portfolio Analysis. Use the data in the previous problem and consider a portfolio with weights of .60 in stocks and .40 in bonds.a. What is the rate of return on the portfolio in each scenario?b.
Risk Premium. If the stock market return in 2004 turns out to be –20 percent, what will happen to our estimate of the “normal” risk premium? Does this make sense?
Diversification. In which of the following situations would you get the largest reduction in risk by spreading your portfolio across two stocks?a. The stock returns vary with each other.b. The stock
Market Risk. Which firms of each pair would you expect to have greater market risk:a. General Steel or General Food Supplies.b. Club Med or General Cinemas.
Risk and Return. A stock will provide a rate of return of either –20 percent or +30 percent.a. If both possibilities are equally likely, calculate the expected return and standard deviation.b. If
Unique versus Market Risk. Sassafras Oil is staking all its remaining capital on wildcat exploration off the Côte d’Huile. There is a 10 percent chance of discovering a field with reserves of 50
Financial Decisions. Fit each of the following terms into the most appropriate space: financing, real, stock, investment, executive airplanes, financial, capital budgeting, brand names.Companies
Value Maximization. Give an example of an action that might increase profits but at the same time reduce stock price.
Corporate Organization. You may own shares of IBM, but you still can’t enter corporate headquarters whenever you feel like it. In what sense then are you an owner of the firm?
Corporate Organization. What are the advantages and disadvantages of organizing a firm as a proprietorship, partnership, or corporation? In what sense are LLPs or professional corporations hybrid
Corporate Organization. What do we mean when we say that corporate income is subject to double taxation?
Financial Managers. Which of the following statements more accurately describes the treasurer than the controller?a. Likely to be the only financial executive in small firmsb. Monitors capital
Real versus Financial Assets. Which of the following are real assets, and which are financial?a. A share of stockb. A personal IOUc. A trademarkd. A trucke. Undeveloped landf. The balance in the
The Financial Manager. Give two examples of capital budgeting decisions and financing decisions.
Financial Markets. What is meant by over-the-counter trading? Is this trading mechanism used for stocks, bonds, or both?
Financial Institutions.We gave banks and insurance companies as two examples of financial institutions. What other types of financial institutions can you identify?
Financial Markets. In most years new issues of stock are a tiny fraction of total stock market trading. In other words, secondary market volume is much greater than primary market volume. Does the
Goals of the Firm. You may have heard big business criticized for focusing on short-term performance at the expense of long-term results. Explain why a firm that strives to maximize stock price
Goals of the Firm. We claim that the goal of the firm is to maximize stock price. Are the following actions necessarily consistent with that goal?a. The firm donates $3 million to the local art
Goals of the Firm. Explain why each of the following may not be appropriate corporate goals:a. Increase market shareb. Minimize costsc. Underprice any competitorsd. Expand profits
Agency Issues. Sometimes lawyers work on a contingency basis. They collect a percentage of their client’s settlement instead of receiving a fixed fee. Why might clients prefer this arrangement?
Reputation. As you drive down a deserted highway you are overcome with a sudden desire for a hamburger. Fortunately, just ahead are two hamburger outlets; one is owned by a national brand, the other
Agency Problems. If agency problems can be mitigated by tying the manager’s compensation to the fortunes of the firm, why don’t firms compensate managers exclusively with shares in the firm?
Agency Problems. Many firms have devised defenses that make it much more costly or difficult for other firms to take them over. How might such takeover defenses affect the firm’s agency problems?
Agency Issues. One of the “Finance through the Ages” episodes that we cite on page 27 is the 1993 collapse of Barings Bank, when one of its traders lost $1.3 billion. Traders are compensated in
Agency Issues. Discuss which of the following forms of compensation is most likely to align the interests of managers and shareholders:a. A fixed salaryb. A salary linked to company profitsc. A
Agency Issues. When a company’s stock is widely held, it may not pay an individual shareholder to spend time monitoring the manager’s performance and trying to replace poor management.Explain
Ethics. The following report appeared in the Financial Times:“Coca-Cola is testing a vending machine that automatically raises the price of the world’s favorite soft drink when the temperature
Present Values. Compute the present value of a $100 cash flow for the following combinations of discount rates and times: a. 10 percent. = 10 years b. = 10 percent. = 20 years c. = 5 percent. t = 10
Future Values. Compute the future value of a $100 cash flow for the same combinations of rates and times as in problem 1.Problem 1Present Values. Compute the present value of a $100 cash flow for the
Future Values. In 1880 five aboriginal trackers were each promised the equivalent of 100 Australian dollars for helping to capture the notorious outlaw Ned Kelley. In 1993 the granddaughters of two
Future Values. You deposit $1,000 in your bank account. If the bank pays 4 percent simple interest, how much will you accumulate in your account after 10 years? What if the bank pays compound
Present Values. You will require $700 in 5 years. If you earn 6 percent interest on your funds, how much will you need to invest today in order to reach your savings goal?
Present Values. Would you rather receive $1,000 a year for 10 years or $800 a year for 15 years ifa. the interest rate is 5 percent?b. the interest rate is 20 percent?c. Why do your answers to (a)
Calculating Interest Rate. Find the annual interest rate. Present Value Future Value Time Period 100 115.76 3 years 200 262.16 4 years 100 110.41 5 years
Present Values. What is the present value of the following cash-flow stream if the interest rate is 5 percent? Year Cash Flow 1 $200 23 2 $400 3 $300
Number of Periods. How long will it take for $400 to grow to $1,000 at the interest rate specified?a. 4 percentb. 8 percentc. 16 percent
Calculating Interest Rate. Find the effective annual interest rate for each case: APR Compounding Period 12% 1 month 8% 3 months 10% 6 months
Calculating Interest Rate. Find the APR (the stated interest rate) for each case: Effective Annual Interest Rate 10.00% Compounding Period 1 month 6.09% 6 months 8.24% 3 months
Growth of Funds. If you earn 8 percent per year on your bank account, how long will it take an account with $100 to double to $200?
Comparing Interest Rates. Suppose you can borrow money at 8.6 percent per year (APR)compounded semiannually or 8.4 percent per year (APR) compounded monthly. Which is the better deal?
Calculating Interest Rate. Lenny Loanshark charges “one point” per week (that is, 1 percent per week) on his loans. What APR must he report to consumers? Assume exactly 52 weeks in a year. What
Compound Interest. Investments in the stock market have increased at an average compound rate of about 10 percent since 1926.a. If you invested $1,000 in the stock market in 1926, how much would that
Compound Interest. Old Time Savings Bank pays 5 percent interest on its savings accounts.If you deposit $1,000 in the bank and leave it there, how much interest will you earn in the first year? The
Compound Interest. New Savings Bank pays 4 percent interest on its deposits. If you deposit$1,000 in the bank and leave it there, will it take more or less than 25 years for your money to double? You
Calculating Interest Rate. A zero-coupon bond which will pay $1,000 in 10 years is selling today for $422.41. What interest rate does the bond offer?
Present Values. A famous quarterback just signed a $15 million contract providing $3 million a year for 5 years. A less famous receiver signed a $14 million 5-year contract providing$4 million now
Loan Payments. If you take out an $8,000 car loan that calls for 48 monthly payments at an APR of 10 percent, what is your monthly payment? What is the effective annual interest rate on the loan?
Annuity Values.a. What is the present value of a 3-year annuity of $100 if the discount rate is 8 percent?b. What is the present value of the annuity in (a) if you have to wait 2 years instead of 1
Annuities and Interest Rates. Professor’s Annuity Corp. offers a lifetime annuity to retiring professors. For a payment of $80,000 at age 65, the firm will pay the retiring professor$600 a month
Annuity Values. You want to buy a new car, but you can make an initial payment of only$2,000 and can afford monthly payments of at most $400.a. If the APR on auto loans is 12 percent and you finance
Calculating Interest Rate. In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $10,000 and the interest rate is 10 percent, the borrower
Annuity Due. Recall that an annuity due is like an ordinary annuity except that the first payment is made immediately instead of at the end of the first period.a. Why is the present value of an
Rate on a Loan. If you take out an $8,000 car loan that calls for 48 monthly payments of$225 each, what is the APR of the loan? What is the effective annual interest rate on the loan?
Loan Payments. Reconsider the car loan in the previous question. What if the payments are made in four annual year-end installments? What annual payment would have the same present value as the
Annuity Value.Your landscaping company can lease a truck for $8,000 a year (paid at yearend)for 6 years. It can instead buy the truck for $40,000. The truck will be valueless after 6 years. If the
Annuity Due Value. Reconsider the previous problem. What if the lease payments are an annuity due, so that the first payment comes immediately? Is it cheaper to buy or lease?
Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25 percent down and 25 percent of the purchase price in each of the next 3 years. If you pay the entire bill
Annuity Value. Reconsider the previous question. How will your answer change if the payments on the 4-year installment plan do not start for a full year?
Annuity and Annuity Due Payments.a. If you borrow $1,000 and agree to repay the loan in five equal annual payments at an interest rate of 12 percent, what will your payment be?b. What if you make the
Valuing Delayed Annuities. Suppose that you will receive annual payments of $10,000 for a period of 10 years. The first payment will be made 4 years from now. If the interest rate is 6 percent, what
Mortgage with Points. Home loans typically involve “points,” which are fees charged by the lender. Each point charged means that the borrower must pay 1 percent of the loan amount as a fee. For

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